Britons pay off debt at record rate

Weak lending, or an absence of once abundant supplies of credit, has been held up by policy makers as one of the biggest threats there is to a sustained economic recovery. Those of a gloomy frame of mind would have found plenty of support for this view in the latest lending data from the Bank of England, which showed that loans to both companies and individuals declined at a record pace in July.

Personal borrowing fell by £600m, which admittedly is not that much when compared to the totality of outstanding loans to individuals of £1.457 trillion, but is none the less a significant reversal in the ever onwards and upwards march of credit that ruled until about a year ago.

Companies have also been paying down debt – private non-financial corporations paid back £8.4bn of their loans in July, or around 1.7 per cent of their total stock of debt. The point taken from these numbers by sceptics of recovery is that both individuals and companies are demonstrating a preference for debt repayment over spending and investment, which is plainly not going to be good for economic activity.

Such behaviour is also a perfectly logical response to the very low interest rate environment that now rules. By substantially reducing mortgage servicing costs for many home owners, the effect of low interest rates has been to add significantly to disposable income. Yet rather than spending all these gains, many individuals seem to be using at least a part of them to pay down their mortgages.

At current interest rates, there is certainly not much point in saving the money. By the same token, it plainly makes sense to reduce the size of the mortgage against the day the loan has to be refinanced at a higher rate. Companies seem to be adopting much the same approach, though debt reduction in the corporate sector is partly explained by alternative sources of finance from bond and equity markets.

Even so, the big picture is that corporations are following the banking sector into an active process of deleveraging. To say that society is becoming increasingly debt averse is over-egging it. Yet with rising unemployment, people worry more about their ability to service their debts and act accordingly.

This may not be particularly good for the economy, but isn't it just what the doctor ordered? Britons have far too much debt. A period of adjustment is both desirable and long overdue if Britain is to achieve the more balanced economy policymakers aspire to.

Unfortunately, there is no such thing as a pain free adjustment. John Maynard Keynes, the economist, called these adverse consequences "the paradox of thrift". As unemployment and recession deepen, people save more to protect themselves against joblessness, which in itself must be a good thing. Yet the consequent reduction in spending causes economic activity to contract further, and so on.

What we are witnessing in this recession is not so much an increased propensity to save as its mirror image of a growing determination to pay down excessive debt built up during the years of plenty. This willingness to repair overstretched balance sheets is obviously desirable on one level, yet it is also bound to limit the economic recovery.

Still, it's not all bad news. The Bank's policy of "quantitative easing" seems finally to be working as desired. Underlying money supply, which includes notes, coin and deposits with banks but excludes the money go round of deposits from volatile parts of the financial services industry, rose at an annualised rate of 5.3 per cent in July. This is still a bit below the average growth in money supply that used to rule before the credit crunch but is a big improvement on the minimal annualised growth rate of the previous three months of little more than 1 per cent.

The new money being created by quantitative easing may in part explain the reduction in overall bank borrowing. Some of this money may be getting applied in a round about way to the business of repairing individual and corporate balance sheets. As desired, QE may in part be counteracting the "paradox of thrift". Certainly, if you'd been to London's Brent Cross shopping centre at the weekend, as I did, you certainly wouldn't have observed much thrift going on there. People seemed to be shopping with the abandon of a top of the market boom.